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Covariation neglect among novice investors

Journal article
Authors Martin Hedesström
Henrik Svedsäter
Tommy Gärling
Published in Journal of Experimental Psychology: Applied
Volume 12
Issue 3
Pages 155-165
Publication year 2006
Published at Department of Psychology
Pages 155-165
Language en
Keywords diversification heuristic, covariation neglect, novice investors, portfolio diversification, 1/n heuristic
Subject categories Psychology

Abstract

In 4 experiments, undergraduates made hypothetical investment choices. In Experiment 1, participants paid more attention to the volatility of individual assets than to the volatility of aggregated portfolios. The results of Experiment 2 showed that most participants diversified even when this increased risk because of covariation between the returns of individual assets. In Experiment 3, nearly half of those who seemingly attempted to minimize risk diversified even when this increased risk. These results indicate that novice investors neglect covariation when diversifying across investment alternatives. Experiment 4 established that naïve diversification follows from motivation to minimize risk and showed that covariation neglect was not significantly reduced by informing participants about how covariation affects portfolio risk but was reduced by making participants systematically calculate aggregate returns for diversified portfolios. In order to counteract naïve diversification, novice investors need to be better informed about the rationale underlying recommendations to diversify.

Page Manager: Webmaster|Last update: 9/11/2012
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